Should I Use a Third Party Company to Find, Buy, and Manage Real Estate Rental Properties?
Investing in rental properties has become increasingly popular amongst physicians over the past decade, and understandably so - these properties come with the promise of cashflow, tax benefits, and income diversification. There are many companies that are seeking to help physicians get involved in this space, and therefore, we often get questions posted in our online communities for doctors about who the good companies to invest alongside of are, and whether it’s a good idea to use a third party company to buy rental properties if you want to be relatively hands off. Below, we’ll go over the things to be cautious about when somebody approaches you with an opportunity like this, particularly in today’s real estate market, and how to properly vet whether a company’s incentives are aligned with yours before investing in a property that they suggest.
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Why invest in real estate rental properties, and what are the benefits of using a third party company to help facilitate dipping into the space?
Before we dig into the weeds, the 30,000 foot view is important. Many physicians want to invest in real estate rental properties because they’ve heard about the tax benefits of investing in real estate, or because the idea of passive income is attractive to them. Both of these reasons are great reasons to get involved in real estate investing - but it’s important to know when these benefits pan out and when they don’t.
The benefits of having somebody else help you get started are obvious - we have limited time as physicians, and finding the time to scour the internet for deals, run numbers (and learn how to run numbers), and deal with paperwork and management companies is hard. It’s tempting to say, “Let somebody else do this for me, and I’ll supply the capital - sure, I’ll make a little less, but at least I can invest in real estate.”
Don’t let the tax tail wag the dog - is the property actually a good investment?
While there can be substantial benefits from investing in rental properties, particularly if you’re able to claim real estate professional status or the short term rental tax loophole, you have to understand that tax benefits are only great if the investment itself is also great. You don’t want to hold a losing property or a liability just so that you can get tax benefits from it. The property itself should be a good investment - the tax benefits are the icing on the cake.
Also, be sure you can actually take the tax benefits that are proposed to you. Depending on the type of investment, how it’s owned, and what your personal situation is, different options for tax benefits will be available to you. Note that depreciation will recapture unless you roll the money into a new investment via something like a 1031 exchange so understand the long game as it relates to your tax situation. When in doubt, talk to your accountant instead of trusting someone else, because they understand exactly how these benefits will flow through on your tax return.
PSG resource: Accountants for Physicians
You yourself should be able to determine if a property is a good investment - do not take anybody’s word for it
Remember, these are companies that have something to gain from you investing in real estate. While the idea of not having to do anything and having others find great properties for you is appealing, it’s a set up for disaster, especially when it comes to sizeable investments. If you want to invest in real estate, you should be willing to put in the time and effort to learning how to underwrite a real estate deal. If you’re not, buyer beware - the promise of easy money is where so many physicians run into regret.
Learn more about how to determine if a rental property is a good investment and cashflows.
PSG Resource: Resources for learning about how to invest in real estate.
As with all of our resources in this realm, do your own due diligence!
“A company said they can handle everything for me - finding a great rental property, taxes, maintenance, etc etc” - what’s the catch?
Nobody works for free - know where they make their money
The first thing you need to understand to see if the company’s interests are aligned with yours is how the company makes their money. Things to think about include:
Do they only make money if you make money?
Do they lose anything if you lose money?
Do they make money off of the transaction when you buy the real estate?
Are they making money off of managing the property, regardless of how the investment is doing?
Just as we mention with our red flags with financial advisors who sell insurance products, it’s important to understand that you are evaluating a salesperson in this situation. It doesn’t mean that they’re bad people, but that you should be wary of a situation where somebody’s making money off of your money at no risk to them. You’re going to want to structure their incentives to line up with yours.
What situations should I be wary of?
Imagine that a company sells you a $250,000 investment, and they’re acting as a buyer and/or seller and making a 3% commission on the sale. That’s $7,500. Now let’s say they’re also renovating the property for you to make it more attractive to renters, and they’re taking a $10,000 contractor markup. Maybe they’re also taking a percentage of the rent as a property manager, so they’re making 8% of the rent each year.
Depending on how deep their network is and how they structure the management agreement, they may also be making fees from things like referring you to someone for financing of the mortgage, leasing and tenant finding fees, maintenance and repairs, a separate asset management fee, or otherwise. They may also take money in commissions when you eventually sell the property.
You’ve put down $250,000. They’ve put down nothing. If the investment doesn’t cashflow, they’re still making money - you’re potentially taking money out of your pocket to maintain it.
Let’s say the property appreciates and they take a fee based on that or sales fees at that time. They’ve made upside from your investment as well, without putting any money down.
Isn’t this all fine if I make money - what do most properties make?
It’s totally fair to say you don’t care that somebody else is making money as long as they make it easy for you to make money.
The question is, in today’s market with higher interest rates, higher purchase prices, and a potentially shaky rental market or occupancy rates that aren’t ideal, will you make money, and if so, how would it stack up against just putting money in the market.
Traditionally, those in real estate will tell you to look for a 10% cash on cash (COC) return at minimum for long term rentals, and higher COC for short term rentals. Many deals that members of our communities are seeing these days are not hitting those numbers.
Then ask yourself, if I’m getting returns less than this, and paying fees to a middleperson on top of that, what are my actual returns? Are they better than putting them in a tried and true boring index fund?
Make sure you’re getting the value out of the relationship that you should, and that incentives are aligned
We aren’t saying you should never use a third party to help you find properties - we just want you to ask the hard questions.
Questions to ask yourself:
Are the fees they take significantly eroding at my profits to the point that the investment no longer makes sense?
Is it possible that the incentive structure makes it easy for them to still make money even if they sell me a bad property?
If I’m not confident about my ability to vet properties, would it be better to pay somebody without as much conflict of interest to help vet a property, without them making all the other fees that introduce incentive to buy properties that may not be the best deal for me?
Questions to ask them:
“If you weren't going to manage this property, would you still recommend that I buy it at this price? Why?
“Would you recommend I buy this property if I used a different property manager?” Why?
Say to them - “Show me exactly how much money your company makes from my purchase, including acquisition fees, renovation, financing, management, leasing, maintenance, and any other compensation.”
Vetting the rental investment properties that a third party company presents to you to buy
Vet the company before you even look at a rental property they present to you
There’s a lot of nascent (read: inexperienced) players in this space who do a great job with marketing, but not necessarily with rental property management or vetting deals. Ask them about their experience and past performances (also noting that past performance doesn’t indicate future performance, but that a bad track record should make you run). Ask:
How many properties do you currently own or manage?
What’s your experience in the real estate industry?
Who’s managing the properties on a day to day basis, and what accountability do they have to you and me?
How do you get access to rental properties for sale, and how does it give you an advantage to getting the good properties before other investors snatch them up?
Are you also buying properties in the same neighborhoods at similar prices? What’s your incentive in giving me a good deal versus keeping it for your own portfolio?
Do you have special access to distressed properties that you can renovate? Show me how that’s worked out for you or one of your investors in the past?
Give me references from others using your company to find and manage deals
Show me aggregate historical performance of properties you’ve bought on behalf of others
After fees, does the property cashflow, and how much - what’s the actual return to you?
Here’s our biggest pearl. Don’t take the spreadsheet they present to you at face value for the ROI of an investment.
If you’re not willing to learn the basics of how to vet a property yourself, you are a sitting duck for being sold on something you may not have bought had you done the numbers yourself.
Do not count on appreciation
A lot of vendors in this space like to point out what the anticipated property appreciation is when they present deals to you, in order to make returns look better.
Do not take their word on this. Nobody has a crystal ball. Appreciation is again, icing on the cake, but not a factor that you can control. Markets change, and property values do depreciate, even in ‘hot’ markets. Make sure the property still makes sense from a cashflow perspective even if it doesn’t appreciate, because that means that you can hold it for a long time without it being a liability. If you’re paying out of pocket to run the rental in hopes of appreciation, you’re holding a liability, not an asset.
Conclusion
From a pure investment standpoint, assuming you know what you’re doing, you’ll likely make more money approaching rental properties yourself without the middleman fees. That said, as a physician, you’re busy, and it’s appealing to have somebody else doing the legwork as well as the maintenance. The big thing is understanding whether a particular company or investment makes sense, and there is no short-changing the diligence there if you want to protect your investment. Ask the right questions, and most importantly, make sure your incentives are aligned.
Real estate investment resources for physicians
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